A burden or a blessing? PFIs look set for a return under Labour

Reports that Rachel Reeves is mooting the use of private finance to fund the £9bn Lower Thames Crossing has fuelled chatter that Private Finance Initiatives could be set for a return.

Private Finance Initiatives, or PFIs, were a staple of Tony Blair’s Labour government, but have become controversial amid debate over whether they were ultimately more expensive in the long run.

A PFI is a long-term contract between a private party and a government entity where the private sector designs, builds, finances and operates a public asset and related services. The private party bears the risk, in terms of construction and maintenance and management, but receives returns as the contract is paid off in the future.

While the new Labour government has made no secret of its intention to use private sector funding to help rebuild and repair Britain’s creaking infrastructure system, particularly in road, energy and water projects, it has not been made clear exactly what this will look like in practice.

A widely cited National Audit Office (NAO) report in 2018 found that the cost of privately financing public projects was around 40 per cent higher than relying only on government funding. It estimated taxpayers would be forced to shell out nearly £200bn to contractors under private finance deals over the next 25 years.

The then-chairwoman of the parliamentary Public Accounts Committee (PAC) at the time, Labour MP Meg Hillier, launched a scathing critique of PFIs, which were stopped that same year.

What the current Chancellor is proposing is likely to be a different model than what was used by the former Labour government. According to the Financial Times, it could include capping returns for investors or close scrutiny by an independent regulator.

While they are controversial, some think a return to PFIs could help improve Britain’s infrastructure system, which has struggled with soaring costs and delays.

Widely seen as the poster boy of the UK’s failure to build, High Speed Two (HS2) has been funded entirely out of Whitehall’s pocket. The development of Battersea Power Station, on the other hand, leveraged in billions in private capital, much of which was pumped into the extension of the Northern Line and a new underground station.

“Private sector funding of infrastructure projects allows a government to share the capital cost of delivering such schemes,” Dominic Lacey, a partner at Eversheds Sutherland, told CityAM “This is clearly an advantage to any government with constraints on its capital investment budget.”

He added: “In addition, private sector participation is perceived to bring efficiencies: with a long term design, build, finance and operate model a focus on whole lifetime cost can be fostered.”

The LTC, a proposed tunnel under the River Thames to the east of London, has been struggling to progress under the weight of its 359,000 page planning application, which is the longest in UK history and nearly 250 times the length of the Russian novel, War and Peace.

The project’s budget has risen to nearly £9bn, from around £5.5bn when it was first suggested, and it has been earmarked for PFI-type investment in the past.

Professor Andy Travers, from the London School of Economics (LSE), told CityAM it would be “substantially easier” to shift projects to the private sector in areas such as London and the south east of England, which are densely populated with a large number of relatively affluent people.

“London can afford to pay for more of these big infrastructure projects than other parts of the country simply because of the large number of people who will use them.”

Critics argue that introducing private sector investment for big road and tunnel projects would likely lead to push back over an increase in tolls and charges for the general public. Banks financing such projects may also be nervous about long-term usage and seek minimum usage or revenue guarantees, while demanding protection for any future competitor schemes or wider impact on traffic levels.

It is generally far easier to introduce road pricing in projects that, like the LTC, have yet to get off the ground and can demonstrate utility, Travis said.

The problem with PFIs is that private investors tend to extract huge returns, leaving public bodies involved with huge debt over time. One South London hospital went bankrupt in 2012 after being forced to spend 14 per cent of its income on repayments to a PFI.

Problems often emerge in the construction of hospitals and schools, Travers said.

Costs are stripped from the government’s books in the short-term but over the course of 25 to 30 years, service charges stack up significantly.

“If you did all of the calculations about what it would have cost to do it with cheaper public money, borrowing at government interest rates… it would actually be cheaper than public money,” he said.

With Reeves caught between the rock of needing to generate economic growth, and the hard place of the government’s worryingly low coffers, could PFIs present a tantalising – if risky – opportunity?